Relaxing bank liquidity rules sparks hope for euro lending boost

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The loosening of liquidity rules due to come into effect on banks raises hopes among some analysts to a recovery of lending the euro zone.

The Basel Committee on Banking Supervision announced over the weekend that it would give banks more time to meet global liquidity rules, phasing them into force from 2015.

The world’s top banking regulatory body also widened what banks could hold to meet the requirement of having 30 days worth of liquid assets in case of a crisis.

The rules are aimed at improving the banking sector’s ability to survive future financial crises, but since they were first proposed in 2010 banks have argued they were too tight and there were concerns they would dampen lending and economic growth.

Originally banks would have had to hold essentially cash, central bank deposits and high-rated government and corporate bonds to meet the so-called Liquidity Coverage Ratio.

Not only would this tie up funds, being forced to hold large amounts of these low-yielding assets would likely prompt banks to make up for lost income by charging higher interest on loans to companies.

“It was already having an impact on lending and the business model of banks,” said Thomas Rocafull, director of financial services at Sia Partners consulting firm in Paris.

However allowing banks to use some stocks and lower-rated corporate debt in the calculation of the Liquidity Coverage Ratio, as well as relaxed assumptions about how much funds would flow out of banks during a crisis, should provide banks with considerable flexibility to meet the rules.

US investment bank Morgan Stanley called the changes “constructive, particularly for EU banks.”

It said the changes to the liquidity rule, alongside other measures, ”...supports our thesis that the most pernicious phase of deleveraging is behind us...”

The bank noted that most banks have already met the original liquidity rules according to data from the Bank of International Settlements (BIS) and that “this could help reduce the drag from low yielding reserves and put some to work.”

Morgan Stanley said it doesn’t expect the change to the liquidity rule to translate quickly into a strong credit impulse in the euro zone given the weak economy and continued uncertainty about sovereign finances, but that it is nevertheless a step in the right direction.

But London-based Capital Economics said it believed the changes to the liquidity rules would not have any major economic impact.

It noted studies by the BIS, IMF and OECD that showed the impact of the liquidity rule on economic growth was likely to be just 0.1 to 0.2 per cent of GDP and that main negative effect on lending costs was from the increase in capital requirements for banks.

Increasing the amount of capital banks hold in order to be able to withstand losses is the other main Basel reform undertaken following the global financial crisis.

Euro zone banks have largely shed assets -- or deleveraged -- in order to improve their capital ratios and reduced lending to companies.

Lending to non-financial companies fell in the euro zone in November for a seventh straight month, according to European Central Bank data.

But banks blame the lending slowdown on weak demand by firms rather than their tightening loan conditions.

The ECB has pumped over a trillion euros into the region’s banks in order to calm the markets and try to revive lending.

While the ECB funds haven’t led to a recovery of lending, Capital Economics and Morgan Stanley agreed that the eased liquidity rules should help eurozone banks when the central bank begins to pull out the money.

“The changes will at least make it easier for some banks to satisfy the requirements when the ample liquidity provided by ’quantitative easing’ is eventually withdrawn,” said Capital Economic’s Chief Global Economist Julian Jessop in a research note.

Many analysts consider the ECB pumping funds into banks to be a form of quantitative easing, although the US Federal Reserve and Bank of England have pumped money into the economy with outright purchases of government and corporate bonds.

Fitch ratings agency said the changes to the liquidity rule make it “...a more realistic parameter for banks...” and that they “...could help minimise any market distortions...”